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When people discuss their investment portfolios, they typically refer to the stocks, bonds,
commodities and real estate they hold. The conversation might also include model weightings, tilt
toward and away from different asset classes, and rebalancing. What we rarely hear about is
cash.

Much of the traditional thinking about cash is well-intentioned but unrealistic. Should you have
six months of living expenses in the bank for emergencies? Sure. Do you? Probably not. That sort of
cash cushion is a luxury that only the wealthiest can afford.

How much cash should there be in your investment portfolio? You might not have given it much
thought.

How much to hold in a portfolio depends on who you are, how you are investing and your
investment horizon.

A hedge-fund manager whose clients demand monthly performance reports has needs different from
those of individual investors with a 20-year horizon. The needs of that long-term investor differ
markedly from someone who is retiring in three years.

Warren Buffett has patiently held as much as $20 billion to $40 billion in cash. He thinks of
cash not just as an “asset class that is returning next to nothing,” but rather as “a call option
that can be priced, relative to the ability of cash to buy assets.” He put that to good use during
the financial crisis, scooping up deeply discounted bargains.

Most investors lack Buffett’s discipline. When markets are rallying, cash in the portfolio is a
drag on performance, returning about zero. The argument for cash in the portfolio is that it doesn’t
go down during market crashes and it allows the purchases of cheap assets a la Buffett at
attractive prices.

But investors rarely can make that buy when markets are crashing. They are simply too scared,
lacking the fortitude or the nerve to pull the trigger. Even those who managed to avoid the 2008
crash found themselves stuck with way too much cash in their portfolios as markets recovered. With
the markets up more than 150 percent since the 2009 lows, many investors are wondering what to
do.

Cash, in modest increments, has a role in any portfolio. But unless you are Warren Buffett, you
should limit it to 2 or